The End Of Systemic Trust: The Canary Just Died

-Jean Claude Juncker, PM of Luxembourg, and the head of the Eurogroup council of eurozone finance ministers

May, 2011

Prior to yesterday, if you were trying to handicap how the unelected leaders of the Eurozone were going to react to a tough situation, you only had to refer to the quote above from Mr. Junker to understand their mindset.

But so long as someone at the ECB was willing to flood the world with free EURs (with significant backup provided the US Federal Reserve) the market closed its eyes, held its breath and took the leap of faith that all was well.

However, post the Cyprus decision, the curtain has been pulled back and wizard revealed with all his faults and warts. The age of innocence is dead and with it died institutional and retail trust, confidence in the system writ large and the rule of law.

It would be hard to over-emphasize how significant the Cyprus situation is. The EU demonstrated under no uncertain circumstances that they will destroy the rule of law to maintain their own power. It was a recognition of tyranny that many of us have always assumed was the case but yesterday became reality.

The damage done here is not related to the size of the haircut - currently discussed between 3 and 13% - but rather that the legal language which each and every investor on the planet must rely on in order to maintain confidence in the system has been subordinated to the needs of the powerful elite. To the power elite making the major decisions in DC, London, Berlin, France, Brussels, et. al., laws are like ice cream, easily melted.

Which begs the question, who is next? Will it be Portugal? Greece? Spain? Italy? France???

The major banks of Europe are levered beyond anyone’s wild guess. They cannot afford a hit to their capital base lest they be exposed for the over-levered giants they are. This, of course, opens up the exposure all of these banks have to the greater than $1tr derivatives market where the failure of any one of these derivative banks could lead to the collapse of them all.

So, of course, the powers that be in Europe must do everything in their power to prevent the world from noticing that their banks are broke. This means they will lie and take anything they deem necessary. Including the forceful seizure of savings accounts of innocent people.

The Government Is Your Friend?

Markets have been rallying for years on the back of the idea that government’s are going “all-in” to save the current economic system. To many of the talking heads on the business channels, we are supposed to view this as a good thing.

This has produced all kinds of non-market based solutions such as the bailout of the major US banks and their subsequent TBTF moniker, the “bailout” (I use the term loosely because this was really a political stunt) of GM and a never-ending stream of free money being handed out by the major central banks.

The markets have seemed to like this ham-handed involvement and have rallied to all-time highs.

But all along the way there have been those of us who have said that there will eventually be a price pay. With the Cyprus decision, investors now know what the price is: your money is not really your money. Your bank account is not really your bank account. Your bonds, stocks, home and anything else you think you own isn’t really yours. The governments of the world will take it from you whenever things get bad enough.

Look at China. Do you think if the global economy ever shrinks far enough that the Chinese will allow all those American companies to keep their assets on Chinese soil? How likely is it that the Chinese will suffer through their own problems of inflation and social instability and yet allow Apple, GE, GM and the rest to keep benefiting?

Think about global mining and oil stocks? Most own assets in countries other than the home domicile of the company. If the prices of precious metals and/or oil ever meaningfully breaks out, do you think the poor governments that originally granted the mining/drilling concessions will simply respect the rule of law and allow these multi-national corporations to keep sending their country’s wealth abroad? Not likely.

How about in the US? Could the US declare a bank holiday and unilaterally devalue the currency in one swift move? I will get over 9,000 responses saying this could never happen in the good ol’ US of A but of course it could. In fact it has already been done before during FDR’s first 100 days in office. The template already exists. Electronic banking only makes the process that much easier.

Technically, since the Fed has been running a policy of monetary inflation since about 1920, the government here already has been quietly taxing the savings accounts of its citizens without their permission for decades. The subtle difference between what Europe is doing in Cyprus and what the Fed does every day to American citizens is that the Cyprus theft is happening in one discrete event while the Fed’s theft drips in slowly over years.

But no matter which way you look at the situation, expect things to deteriorate from here.

Lehman Part Deux

What could be next?

Bank runs will continue apace where they are already going and will begin in countries previously seen as impervious to such events such as France, Germany and even Switzerland.

The difference in pricing between the paper and physical precious metals markets will rise. Good luck to those of you owning paper gold and thinking this will help you when things get bad. The legal language on your piece of paper is worthless. If savings accounts aren’t sacrosanct, then neither is that ETF.

Did you or your firm stash a bunch of money off-shore in some tax-friendly haven that probably has a favorable relationship to the British Crown? Best of luck with that. Tax havens are nothing more than legal arbitrages. With the value of law moving to zero, the value of your account approaches the same.

Trade wars will begin to rear their ugly heads as the losers in the currency wars retreat to their last line of defense. Once you tear up the rule of law, trade agreements quickly get thrown by the wayside once your domestic situation deteriorates enough.

Moar and moar government micro-management of individual economies, markets, sectors and companies. The Amateur Barack Obama and his minions will continue the tradition started by George II of abandoning free market principals to ostensibly save the free market. Once they are done there will be little left of the market and none of us will be free.